‘There has been a profound
transformation in how Americans define needs and wants’

Robert D. Manning

8
In their provocative article, Elizabeth Warren and Amelia Warren
Tyagi challenge prevailing assumptions about the unprecedented
rise in U.S. household debt. Americans, they argue, have changed
little in their traditional preference for providing a basic material
standard of living for their families and, in particular, providing
economic security for their children through high-quality education,
health care, transportation, and other essential needs. Parents
today behave much like parents past: they respond rationally to
the changing costs of middle-class essentials—even if that
now entails assuming unprecedented levels of debt.

While this focus on rising
costs illuminates certain aspects of the problem of consumer debt, it
also oversimplifies the causes and consequences of such debt. I
propose here to explore some of these complicating
factors.

Individuals commonly accumulate their highest levels of
debt at the beginning and middle stages of their careers, due to
educational debt and low salaries or wages. Households also
accumulate a large amount of consumer debt during their early stages
because this is when many people purchase a home and have children;
the cost of this latter choice is increased if a mother temporarily
withdraws from the labor market in order to care for young children.
Traditionally, then, households pay off their debts and start saving
and investing as their incomes increase. As families fulfill their
obligation of providing for their children, they are assumed to
accumulate the bulk of their household wealth in the last decades of
their careers and to augment their savings through intergenerational
wealth transfers. Warren and Tyagi do not consider such life-cycle
patterns, and a common critique of the over-indebtedness argument is
that its analysis typically focuses on specific points in time rather
than on the entire life course of individuals and households.

One
of the benefits of a life-cycle analysis is that it helps us to
distinguish household dynamics from behaviors and experiences that
vary across historical periods (cohort effects). In a recent study on
the changing cognitive attitudes and behaviors of American
households, I examined the experiences of six different life-cycle
groups (college students, young singles, young families, mature
families, empty nesters, and seniors), and found that the commitment
to saving has fallen from previous generations. Two key factors in
this change merit attention.

First, while the oldest age cohorts
(empty nesters and seniors) still embrace self-discipline, pursue
saving over debt, and share an aversion to debt-based consumption,
their children and grandchildren are less wedded to such traditional
values. The unrelenting financial demands of younger family members
result in intergenerational wealth transfers at earlier stages, and,
together with the sharp increase in the costs of elder medical care,
this dramatically shrinks the nest egg that most middle-class seniors
are able to pass along at the ends of their lives.

Second, these
shifting views about saving and debt reflect a profound
transformation over the past 30 years in Americans’ definition of
“needs” versus “wants.” For example, parents now see costly
extracurricular activities as needs, essential to creating
opportunities for their children: ballet lessons, musical
instruments, scout uniforms, tutoring, summer camps. Admittedly, many
of these expenses reflect the underfunding of public institutions.
Nevertheless, in my research I found that many parents were spending
on their children’s “socially required” high-school activities
instead of saving for their children’s college educations—a major
contributor to the soaring debt levels of recent college graduates.
Furthermore, I found that younger cohorts perceive credit as a social
entitlement to support their lifestyles, whereas earlier generations
viewed consumer credit as an earned privilege that assisted in
providing for their household needs. The resulting modern view of
“responsible” budgeting sharply departs from traditional
attitudes and behaviors: it emphasizes minimum monthly payments and
no savings.

The most intriguing example of the cognitive change
toward saving and debt is the simultaneous pursuit of both.
Traditionally, American families began to invest after first paying
off their consumer debt, with the exception of their home mortgage
and possibly their auto loans. Today, Americans are investing in
their IRAs or 401(k)s long before they have even accumulated any net
assets. This change is underscored by the confounding attitudes
toward home ownership. Invariably, among both young and mature
families, housing is primarily seen as an investment rather than as a
marker of security. Most people, however, are unaware of how much
price appreciation is necessary for a profitable housing investment
after adding the costs of finance charges, realtor and closing fees,
taxes, insurance, and maintenance. For many families, the decision to
spend more on housing rather than diversify their investment
portfolio (stocks, bonds, mutual funds, rental properties) will
intensify the pressure to save a much higher proportion of their
income at the later stages of their work careers. Significantly, this
situation makes them more likely to become even more reliant on
consumer credit, which suggests that they will eventually retire with
high levels of debt.

Another factor complicating the story of
consumer debt—albeit one that Warren and Tyagi address in more
detail elsewhere—concerns the impact of post-1980 banking
deregulation on the supply of consumer finance. Warren and Tyagi
imply that banks simply serve to satisfy family lifestyle demands by
extending new forms of consumer credit. In reality, U.S. banks faced
a profitability crisis in the early 1980s that led to a rapid shift
from corporate and wholesale lending to consumer (retail) lending. As
banks developed new loan products, such as revolving loans (e.g.,
credit cards) and home-equity loans, they aggressively sought new
clients who were willing to assume higher debt levels as well as high
fees and interest rates. As traditional bank underwriting standards
have been reduced, consumers have been deluged with loan
offers—secured (refinancings, home equity), installment (auto), and
unsecured (credit cards). Currently, the high profitability of
consumer lending essentially subsidizes underperforming bank
divisions, which in turn intensifies institutional pressures to find
new clients and to raise the cost of borrowing.

Since deregulation
there has been a dramatic consolidation of the consumer financial
services industry and a subsequent decline of the community banking
system; the latter, with its risk-averse lending policies, had served
as an institutional constraint to high levels of household debt. As a
result, the difficulty of increasing a family’s income is obscured
by the ease of obtaining consumer loans. This has not only
precipitated recent household-debt-consolidation frenzies through
home equity and refinancings (which mask the sources of family
indebtedness), but also the increase in the total cost of debt
service, as adjustable rate loans (mortgages, home equity, credit
cards) begin to climb in accordance with rising Federal Reserve
interest rates. Not incidentally, the most financially distressed
households have become dependent upon leases (e.g., automobile) and
usurious loans that are not recorded as debts by the U.S. government
(payday loans, rent-to-own contracts).

The causal factors
underlying the rising economic distress of the middle class merit
brief mention. Although Warren and Tyagi focus on domestic policy and
the American family as their primary analytical unit, the reality is
much more complex today than it was in the 1950s and 1960s.
Globalization and the neoliberal trade regime have intensified
pressure throughout American society to promote consumption over
savings. American consumption levels must increase in order to
sustain the ever-growing volume of international “free trade,”
even as the global production of cheaper goods and services puts downward
pressure on U.S. wages and services. Increasing household reliance on
cheap imported products has ultimately exacerbated the financial
distress of American families and relocated a higher proportion of
the world’s middle classes from the United States to developing
societies such as India, Brazil, and Eastern Europe. This has led
some observers to assert that the fastest-growing U.S. export is
American-style consumer debt. (Notably, the United States is the only
Western industrialized country that has deregulated its consumer
financial services industry and tightened its consumer bankruptcy
laws. Canada, the United Kingdom, France, and even Australia have all
liberalized their debt-forgiveness statutes.)

Soaring levels
of U.S. consumer debt cannot, then, be explained simply as the
product of voracious American consumers, nor by intransigent
structural economic factors that underlie increasing social
inequality. Rather, both perspectives offer instructive insights. But
a crucial part of the story is the drama of social and economic
mobility that pits generation against generation and neighbor against
neighbor in a competition that has increasingly assumed materialist
dimensions. The reality for most Americans is growing economic
insecurity. As global forces continue to shape American industry and
economic inequality, my grave concern is that the discussion of
consumer debt may understate these forces’ most deleterious
long-term consequences and thus postpone the formulation of
desperately needed public-policy initiatives addressing inadequate
health care, underfunded public education, and the impending
retirement crisis. <

Robert D. Manning
is a professor of finance at Rocheste rInstitute of Technology
and the author of Credit Card Nation and the forthcoming
Give Yourself Credit His Web site is http://www.creditcardnation.com.